Mergers and lawsuits

Shark attack

Why American firms cannot do deals without being sued

KURT VONNEGUT wrote that: “In every big transaction, there is a magic moment during which a man has surrendered a treasure, and during which the man who is due to receive it has not yet done so. An alert lawyer will make the moment his own, possessing the treasure for a magic microsecond, taking a little of it, passing it on.” Like so many novelists, he was talking bosh. No alert lawyer takes only “a little”.

Consider the shark-munched world of mergers and acquisitions (M&A). In 2005, 39% of M&A deals were challenged by lawsuits, one study found. By 2011 a hefty 96% of acquisitions worth more than $500m were attracting suits, according to Robert Daines of Stanford University (who spotted the Vonnegut quote) and Olga Koumrian of Cornerstone, a consultancy. Each deal was hit by an average of 6.2 lawsuits. Many were filed within hours of the deal's announcement; 65% within two weeks.

Plaintiffs' lawyers insist that the process can be healthy—a view with which Mr Daines has some sympathy. Those representing shareholders of the company being bought typically sue for more money, better terms or more disclosure. Sometimes light is shed on a murky process: plaintiffs won $89.4m when they challenged the purchase of Del Monte, a food company, by Kohlberg Kravis Roberts, a private-equity firm. (Barclays, the investment bank involved, was accused of a conflict of interest.)

However, the judge who approved that suit, J. Travis Laster of Delaware's Chancery Court, had also become an outspoken public critic of “worthless”, “sue-on-every-deal” lawsuits. In March he told one group of plaintiffs' lawyers: “I don't think for a moment that 90%—or based on recent numbers, 95%—of deals are the result of a breach of fiduciary duty.”

Most such lawsuits are now settled with the plaintiffs receiving only additional disclosures about the deal. The plaintiffs may or may not benefit. (Their lawyers, naturally, say they do.) But the lawyers certainly gain: to the tune of about $1.2m per settlement last year. Since this is less than 0.1% of the average deal's value, and both sets of directors have staked a lot on the sale, settlement even of nuisance suits is usually the least-bad option.

Randall Baron, the lawyer at Robbins Geller Rudman & Dowd who won the settlement in the Del Monte case, says: “There are four or five [plaintiffs'] firms that bring value, and [others] that bring suits for a quick buck,” inspired by the success of firms like his. Most big American companies are incorporated in Delaware, a tiny state known for sophisticated corporate law and experienced courts. Delaware's judges—in public comments like those of Judge Laster and from Leo Strine, head of the Chancery Court—are signalling that they will begin cutting awards of legal fees to those lawyers who bring copy-and-paste suits that merely win a quick extra disclosure or two.

That might deter the most egregious “frequent filers”. The judges want to reward those who bring good suits, while punishing time-wasters. The judges also want to preserve Delaware's unique influence as America's incorporation capital. But the balance is hard to strike. And in response, more plaintiffs' lawyers are filing outside Delaware (usually where the company is headquartered, rather than where it is incorporated). With several suits on nearly every deal, defendants find themselves in an expensive and time-consuming multi-state mess.

Nonetheless, Mr Baron argues that M&A lawsuits benefit shareholders. Some deals involve manipulation and deception. Lawyers like him do what the regulators would if they weren't so understaffed, he says. Others see it differently. Patrick Gibbs of Latham & Watkins, which defends companies in such cases, points out that only companies that buy others all the time (such as private-equity firms) have enough incentive to fight rather than settle. Others will take the path of least resistance and pay the litigators to go away. Which is why M&A lawsuits are here to stay.